Cyprus bailout stems turmoil

A preliminary agreement has been reached paving the way for Cyprus to receive a $A12.49b bailout.Source: AAP

CYPRUS has secured a 10 billion euro ($A12.49 billion) bailout in return for a radical reform of its banking sector.

The last-minute deal with international creditors is hoped to save the island from bankruptcy and prevent further turmoil across the eurozone.

The agreement deals a major hit to investors and depositors in the island's biggest bank, the Bank of Cyprus (BoC), many of whom are Russian, and will also effectively shut down its second-largest lender, Laiki.

While the participants of the 11th-hour negotiations hailed the deal, Russia said it would study its consequences.

Cyprus President Nicos Anastasiades, who battled for 12 hours with eurozone partners and the International Monetary Fund (IMF) for the deal and at one point issued a veiled threat to resign, said he was "content".

The head of the Eurogroup of finance ministers, Jeroen Dijsselbloem, insisted: "We've put an end to the uncertainty that affected Cyprus and the euro area over the last few days."

Under the agreement, the Laiki bank is to be wound up and major depositors at the Bank of Cyprus will face a "haircut" of 30 per cent, according to a government spokesman.

The deal spares all depositors with less than 100,000 euros ($A124,900) in the island's banks, a key condition missing from a previous agreement that parliament rejected last week.

News of the deal - the fifth eurozone bailout after aid for Greece, Ireland, Portugal and for Spanish banks - boosted financial markets in Asia and Europe on Monday.

The euro also gained to $1.3037 from $1.2986 late on Friday in New York.

A big unknown is the reaction of Russian investors, who hold $US31 billion in private and corporate accounts in Cyprus.

Moscow has also lent the nation 2.5 billion euros, a loan for which Cyprus is hoping to ease the terms of repayment.

In Moscow's first official response to the rescue, Prime Minister Dmitry Medvedev said: "We have to figure out what this story turns into in the long run, what the consequences for the international financial and monetary system will be - and thus, for our own interests as well."

Cyprus has become heavily reliant on banking deposits, including those of dubious origin, which have swollen to roughly four times the size of the country's entire economy, and the biggest investors stand to lose the most in the end.

German Finance Minister Wolfgang Schaeuble said the deal was "a fair one for everybody involved."

It will help "stabilise the situation in Cyprus and help Cyprus back onto a path of sustainable consolidation. I think the solution can help win back lost confidence for an in Cyprus," he said.

The agreement, reached before a Monday deadline set by the European Central Bank, is designed to come up with almost six billion euros, to which the European Union, ECB and IMF are to add about 10 billion euros in loans, allowing Cyprus to save most of the banks which found themselves in trouble after taking part in a huge write-off of privately-held Greek debt last year.

But the Cypriot financial sector, a major pillar of the economy, has suffered severe damage, and some analysts noted the country could now be in for a painful economic contraction that would make it hard to pull itself out of trouble.

"We see a risk that Cyprus' sovereign debt burden post-bailout might not be sustainable, as the country is likely to enter a deep recession caused by the shrinkage of the banking sector and severe deleveraging," or paying down of debt, UBS economist Reinhard Cluse said.

"As the deposit base is likely to shrink, we think that local banks might become more, not less, reliant on the ECB's Emergency Liquidity Assistance (ELA)."

Under terms of the agreement, risky assets held by Laiki are to be transferred to a "bad bank" that is slowly wound up.

The valid assets are to be integrated into the BoC, which is then to be recapitalised, a process that would involve a substantial conversion of uninsured deposits into bank equity.

Big investors are expected to be dealt a painful blow - and the BoC holds the lion's share of the island's Russian deposits.

Dijsselbloem, who is also the Dutch finance minister, could not say when the banks on Cyprus would re-open, nor when restrictions on cash withdrawals and other capital controls would be eased.

The banks had been scheduled to reopen on Tuesday after remaining closed for 10 days.

While details of the final bailout remain sketchy, they will also probably involve a Cypriot government austerity program, privatisations and tax changes at a time of deepening recession given job losses at banks and companies losing out on deposits.

European Union Euro Commissioner Olli Rehn said new economic forecasts for Cyprus would need to be drawn up quickly to take account of the deal.

Economists have forecast the economy could now contract by around 10 per cent this year and by 8.0 per cent in 2014.

But IMF head Christine Lagarde said the deal provided "a comprehensive and credible plan to deal with the current economic challenges in the country".

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